The Reserve Bank of India (RBI) has just issued new guidelines to banks and lenders on how they can charge borrowers for defaults, missed payments, or violations of terms. These guidelines aim to bring clarity and fairness to the way banks impose extra charges on borrowers who fail to meet their payment obligations.
In a circular released recently, the central bank outlined its expectations for Regulated Entities (REs), which include banks and lenders, in ensuring that any punitive interest they impose is reasonable and transparent. This move comes as a response to the inconsistent practices among various REs that have resulted in customer complaints and dissatisfaction.
The RBI stated that the purpose of imposing punitive interest or charges is to promote responsible borrowing behavior. These charges should not be seen as a way for banks to generate additional revenue beyond the agreed-upon interest rates.
To address the concerns stemming from these practices, the RBI has issued specific instructions. One key point highlighted by the RBI is that any penalties for borrowers failing to meet the significant terms and conditions of a loan contract should be classified as “penal charges” rather than being integrated as additional “penal interest” on top of the loan’s interest rate.
The RBI emphasized that there should be no compounding of penal charges. This means that no additional interest should be calculated based on these charges. However, this principle does not impact the standard procedures for compounding interest in the loan account.
Furthermore, the RBI mandates that banks and lenders should refrain from adding any new components to the interest rate. They should strictly adhere to these guidelines both in their words and actions.
The central bank also requires REs to create board-approved policies regarding penal charges or similar fees on loans. This policy should ensure that the quantum of penal charges is fair and appropriate, corresponding to the severity of the borrower’s non-compliance with loan terms. Importantly, these charges should not discriminate against specific categories of loans or borrowers.
To ensure transparency, REs must explicitly state the amount and rationale behind penal charges in loan agreements, Key Fact Statements, and other relevant documents. This information should also be prominently displayed on the REs’ official websites.
Moreover, when reminding borrowers of their contractual obligations, banks must inform them of the applicable penal charges. Any instance of levying such charges and the underlying reasons should be communicated to borrowers as well.
The RBI’s directives are scheduled to take effect on January 1, 2024. REs are expected to align their policies and practices with these guidelines for all new loans issued or renewed from that date onwards. For existing loans, the transition to the new penal charges system should occur at the next review or renewal date or within six months of the circular’s effective date, whichever comes earlier.